'Bond bubble' will not pop, say bouyant advisers

Warnings to investors that the 'artificially high' gilts market is about to collapse are dismissed by many City fund managers. Simon Read reports

Bonds have been the investment story of the year but it could be time to take profits and get out, according to a leading fund manager. Robin Geffen, the chief executive of Neptune Investment Management, warns that bonds are being kept artificially high, leading to a risky bubble.

"When the Government borrows 12 per cent of GDP in a single year and the Bank of England buys, ahem, 12 per cent of GDP worth of government bonds in one year under its quantitative easing programme, I believe that the price is being kept somewhat artificially high," he says.

"Is the government deficit likely to close next year? Not by much. Is the Bank of England likely to repeat its trick next year? No it isn't. So I believe that there is a bond bubble."

Investors have piled into gilts – government bonds – and corporate bonds during the course of 2009 as they fled the fluctuating equity markets. According to figures from the Investment Management Association, almost twice as much was invested in bond funds in the year to the end of September as it was in equity funds. Some £10.3bn of investors' money flowed into bond funds during the 12 months compared to just £5.9bn into equity funds.

While September's figures showed a slight reversal of that trend – and October's figures, which will be published tomorrow may reveal a further focus back on equity funds – if Geffen is right, many investors could be taking a major risk by leaving their money in bonds.

However, it's not too difficult to find rival experts happy to take up a contrary position to Geffen. Many believe that, far from there being a bond bubble, bonds still offer excellent opportunities for investors.

"Investors are obsessed with bubbles at the moment," complains Gary Reynolds, the chief investment officer at Courtiers. "There is no bond bubble so it will not burst. The last time that gilt prices crashed was in the 1970s when we had supply-side problems and rampant inflation. Today, there is stacks of supply and inadequate demand which means bond prices will not collapse."

Brian Dennehy, the managing director of Dennehy, Weller & Co agrees that there is no bond bubble. "Broadly, prices are back to where they were a couple of months before Lehmans went bust," he points out. "There's still lots of value in bank bonds compared to where they were in, say, 2007."

But he advises investors to lower their expectations. "You're not going to make 50 per cent in the next six months, as you might have done in the last six months. I'd expect returns of between 5 to 10 per cent per annum over each of the next three years."

Bonds work as a form of IOU, meaning that when you buy a bond you are, in effect, lending the issuer money which it promises to pay back on a specified date. They normally last set periods such as five years and, in the meantime, pay interest.

It's that interest – or yield – which makes them attractive, particularly when savings rates have hit rock bottom and remained there for most of the year. But during that time, yields have narrowed, leaving bonds looking less attractive and over-invested.

"With government bonds, yields are low because interest rates are at unprecedented low levels, which reflects a lot of uncertainty about the global situation," says Chris Iggo, the chief investment officer at Axa Investment Managers. "However, the corporate bond market is still attractive as the yield is much higher than with gilts. I believe corporate bonds with maturities of one to three years are still a good place to park your money."

Adrian Lowcock, a senior investment adviser at Bestinvest says: "As a result of the rise in capital values we have reduced our exposure on corporate bonds but remain positive on the sector. Investors should look to get exposure through Strategic Bond Funds such as M&G Optimal Income or Legal and General Dynamic Bond."

However, Paul Feeney, the head of distribution for BNY Mellon Asset Management, says investors wanting income should start looking at equity income funds. "Newton has a range of four funds offering yields ranging between 4.8 per cent and 8.8 per cent from investing in blue chip global companies," he says. "These funds offer good investment opportunities for investors looking for income in 2010, as well as a diversification away from a saturated corporate bond market."